Posts Tagged ‘tradable permits’

After two weeks of negotiations between the 195 countries attending the COP21 climate change conference in Paris, a deal has been reached on tackling climate change. Although the deal still has to be ratified by countries, this is a major step forward in limiting global warming. Before it can formally come into force, it must have been ratified by at least 55 countries, accounting for at least 55% of global greenhouse gas emissions.

The deal goes much further than previous agreements and includes the following:

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A limit on the increase in global temperatures to ‘well below’ 2°C above pre-industrial levels and efforts pursued to limit it to 1.5°C.

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A recognition that the pledges already made ahead of the conference by 186 countries and incorporated into the agreement are insufficient and will only limit global temperature rise to 2.7°C at best.

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Countries to update their emissions reductions commitments every five years – the first being in 2020. Such revised commitments should then be legally binding.

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A global ‘stocktake’ in 2023, and every five years thereafter, to monitor countries’ progress in meeting their commitments and to encourage them to make deeper cuts in emissions to reach the 1.5°C goal. This requires a process of measurement and verification of countries’ emissions.

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To reach a peak in greenhouse gas emissions as soon as possible and then to begin reducing them and to achieve a balance between sources and sinks of greenhouse gases (i.e. zero net emissions) in the second half of this century.

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Developed countries to provide the poorest developing countries with $100bn per year by 2020 to help them reduce emissions. This was agreed in Copenhagen, but will now be continued from 2020 to 2025, and by 2025 a new goal above $100bn per year will be agreed.

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The development of market mechanisms that would award tradable credits for green projects and emissions reductions.

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A recognition that the ‘loss and damage’ associated with climate-related disasters can be serious for many vulnerable developing countries (such as low-lying island states) and that this may require compensation. However, there is no legal liability on developed countries to provide such compensation.

Perhaps the major achievement at the conference was a universal recognition that the problem of global warming is serious and that action needs to be taken. Mutual self interest was the driving force in reaching the agreement, and although it is less binding on countries than many would have liked, it does mark a significant step forward in tackling climate change.

But why did the conference not go further? Why, if there was general agreement that global warming should be tackled and that global temperature rise should ideally be capped at 1.5°C, was there not a binding agreement on each country to apply this cap?

There are two reasons.

First, it is very difficult to predict the exact relationship, including its timing, between emissions and global temperature rise. Even if you could make limits to emissions binding, you could not make global temperature rise binding.

Second, even if there is general agreement about how much emissions should be reduced, there is no general agreement on the distribution of these reductions. Many countries want to do less themselves and others to do more. More specifically, poor countries want rich countries to do all the cutting while many continue to build more coal-fired power stations to provide the electricity to power economic development. The rich countries want the developing countries, especially the larger ones, such as China, India and Brazil to reduce their emissions, or at least the growth in their emissions.

Then there is the difference between what countries vaguely pledge at a global conference and what they actually do domestically. Many developed countries are keen to take advantage of currently cheap fossil fuels to power economic growth. They are also still investing in alternative sources of fossil fuels, such as through fracking.

As we said in the previous blog, game theory can shed some useful insights into the nature and outcome of climate negotiations. ‘The global optimum may be for a strong agreement, binding on all countries. The Nash equilibrium, however, may be a situation where countries push for their own interests at the expense of others, with the final agreement being much more minimalistic.’

‘Minimalistic’ may be too strong a description of the outcomes of the Paris conference. But they could have been stronger. Nevertheless, judged by the outcomes of previous climate conferences, the deal could still be described as ‘historic’.

The Paris Climate Change Conference (COP21) is under way. At the opening on November 30, 150 Heads of State gathered in Paris, most of whom addressed the conference. With representatives from 195 countries and observers from a range of organisations, the conference is set to last until 11 December. Optimism is relatively high that a legally binding and universal agreement will be reached, with the aim of keeping global warming below 2°C – what is generally regarded as a ‘safe’ limit.

But although it is hoped that a successor to the Kyoto Protocol of 1997 will be put in place, there are many problems in getting so many countries to agree. They may all wish to reduce global warming, but there is disagreement on how it should be achieved and how the burden should be shared between countries.

There are several difficult economic issues in the negotiations. The first is the size and impact of the external costs of emissions. When a country burns fossil fuels, the benefits are almost entirely confined to residents of that county. However, the environmental costs are largely external to that country and only a relatively small fraction is borne by that country and hardly at all by the polluters themselves, unless there is a carbon tax or other form or penalty in place. The problem is that the atmosphere is a common resource and without collective action – national or international – it will be overused.

The second problem is one of distribution. Politicians may agree in principle that a solution is necessary which is equitable between nations, but there is considerable disagreement on what is meant by ‘equitable’ in this context. As the third Guardian article below puts it:

The most important hurdle could be over whether industrialised countries like the US, UK and Japan, which have contributed the most to the historical build-up of emissions, should be obliged to cut more than developing countries. India, on behalf of many poor countries, will argue that there must be “differentiation” between rich and poor; but the US wants targets that are applicable to all. A collision is inevitable.

A third problem is that of uncertainty. Although there is general agreement among scientists that human action is contributing to global warming, there is less agreement on the precise magnitude of the causal relationships. There is also uncertainty over the likely effects of specific emissions reductions. This uncertainty can then be used by governments which are unwilling to commit too much to emissions reductions.

A fourth difficulty arises from the intertemporal distribution of costs and benefits of emissions reductions. The costs are born immediately action is taken. Carbon taxes or charges, or subsidies to renewables, or caps on emissions, all involve higher energy prices and/or higher taxes. The flows of benefits (or lower costs), however, of reduced emissions are not likely to be fully experienced for a very long time. But governments, whether democratic or dictatorships, tend to have a relatively short time horizon, governed by the electoral cycle or the likelihood of staying in power. True, governments may not be solely concerned with power and many politicians may have genuine desires to tackle climate change, but their political survival is still likely to be a major determinant of their actions.

Of course, if there is strong public opinion in favour of action to reduce emissions, governments are likely to respond to this. Indeed, all the expressions of public support for action ahead of the conference from all around the world, do give some hope for a strong agreement at the Paris conference. Nevertheless, there is still widespread scepticism in many countries over the relationship between human action and climate change, and many argue that the costs of policies to tackle climate change exceed the benefits.

Game theory can shed some insights into the difficulties ahead for the negotiators. The global optimum may be for a strong agreement, binding on all countries. The Nash equilibrium, however, may be a situation where countries push for their own interests at the expense of others, with the final agreement being much more minimalistic.

There do, however, seem to be more reasons to be cheerful at this summit that at previous ones. But negotiations are likely to be hard and protracted over the coming days.

The Governor of California, Jerry Brown, has issued an executive order to cut greenhouse gas emissions 40% from 1990 levels by 2030 (a 44% cut on 2012 levels). This matches the target set by the EU. It is tougher than that of the US administration, which has set a target of reducing emissions in the range of 26 to 28 percent below 2005 levels by 2025.

The former Governor of California, Arnold Schwarzenegger, had previously set a target of reducing emissions 80% below 1990 levels by 2050. Brown’s new target can be seen as an interim step toward meeting that longer-term goal.

There are several means by which it is planned to meet the Californian targets. These include:

a focus on zero- and near-zero technologies for moving freight, continued investment in renewables including solar roofs and distributed generation, greater use of low-carbon fuels including electricity and hydrogen, stronger efforts to reduce emissions of short-lived climate pollutants (methane, black carbon and fluorinated gases), and further efforts to create liveable, walkable communities and expansion of mass transit and other alternatives to travelling by car.

Some of these will be achieved through legislation, after consultations with various stakeholders. But a crucial element in driving down emissions is the California’s carbon trading scheme. This is a cap-and-trade system, similar to the EU’s Emissions Trading Scheme.

The cap-and-trade rules came into effect on January 1, 2013 and apply to large electric power plants and large industrial plants. In 2015, they will extend to fuel distributors (including distributors of heating and transportation fuels). At that stage, the program will encompass around 360 businesses throughout California and nearly 85 percent of the state’s total greenhouse gas emissions.

Under a cap-and-trade system, companies must hold enough emission allowances to cover their emissions, and are free to buy and sell allowances on the open market. California held its first auction of greenhouse gas allowances on November 14, 2012. This marked the beginning of the first greenhouse gas cap-and-trade program in the United States since the group of nine Northeastern states in the Regional Greenhouse Gas Initiative (RGGI), a greenhouse gas cap-and-trade program for power plants, held its first auction in 2008.

Since January 2014, the Californian cap-and-trade scheme has been linked to that of Quebec in Canada and discussions are under way to link it with Ontario too. Also California is working with other west-coast states/provinces, Oregon, Washington and British Columbia, to develop a co-ordinated approach to greenhouse gas reductions

To achieve sufficient reductions in emissions, it is not enough merely to have a cap-and-trade system which, through trading, encourages an efficient reduction in emissions. It is important to set the cap tight enough to achieve the targeted reductions and to ensure that the cap is enforced.

In California, emissions allowances are distributed by a mix of free allocation and quarterly auctions. Free allocations account for around 90% of the allocations, but this percentage will decrease over time. The total allowances will decline (i.e. the cap will be tightened) by 3% per year from 2015 to 2020.

At present the system applies to electric power plants, industrial plants and fuel distributors that emit, or are responsible for emissions of, 25,000 metric tons of carbon dioxide equivalent (CO2e) per year or more. The greenhouse gases covered are the six covered by the Kyoto Protocol ((CO2, CH4, N2O, HFCs, PFCs, SF6), plus NF3 and other fluoridated greenhouse gases.

There has been much criticism of the European Emissions Trading Scheme, the world’s most significant cap-and-trade (tradable permits) scheme for curbing greenhouse gas emissions. The main criticism is that the scheme has failed to make significant cuts in pollution. The cap was so loose in the first phase (2005–07) that by the end of this period, carbon was trading for as little as €0.02 per tonne. Although the cap on emissions was tightened by 7 per cent for phase 2 (2008–12) (see Economics, 7th ed, Box 12.5), causing the carbon price to rise to about €30.00 per tonne by mid 2009, since then the price has fallen as industry has cut output in response to the recession. By February 2010, the carbon price was around €12.50 per tonne (see the Guardian article Carbon price falls to new low). For carbon price data see the European Climate Change site.

The experience of the ETS has resulted in many people in the USA and elsewhere calling for the use of carbon taxes rather than cap and trade as the best means for reducing greenhouse gas emissions. Others have called for a mix of measures. In the US Senate, three senators are seeking to overturn cap-and-trade proposals and take a sector-by-sector approach to cutting emissions.

But increasingly the evidence, supported by economic argument, is that cap and trade does work – or can be made to work – and that it is a better policy tool than carbon taxes. The following articles look at cap and trade and assess whether it really is the best alternative.

UK Parliament’s Environmental Audit Committee has concluded that the European Emissions Trading Scheme (ETS) is not working as it should. Thanks to a total emissions cap that is too low in a time of recession, the carbon price has fallen. The result is that there is no longer sufficient of an incentive for firms to invest in green technology. As the Financial Times article (below) reports:

The committee has urged the government to consider other measures, such as a floor price for carbon dioxide emissions, which would provide industries with greater certainty over the price of carbon and help to ensure the system of pricing was effective.

The MPs said a price of €100 per tonne of CO2 could be necessary to encourage investment, compared with current prices of about €13.

So is the committee correct? Or is a low price of carbon merely temporary, with firms realising that the price will rise as the European economy recovers? The following articles examine the issues.

In the run-up to the United Nations climate Change conference in Copenhagen from 7 to 18 December, many countries have been setting out their preliminary positions. The conference aims to set the terms for the agreement that will succeed the Kyoto Protocol in 2012.

Senior scientists, economists and politicians have been warning about the dire necessity of reaching a comprehensive agreement. One such economist is Sir Nicholas Stern. He argues that the EU should impose a unilateral cut in greenhouse gas emissions of 30% from 1990 levels by 2020, irrespective of the any agreement in Copenhagen. The EU has pledged to increase its targeted cut from 20% to 30% only if substantive progress is made at the talks.

Other countries have set out their preliminary positions. China has offered to reduce its carbon intensity by 40% (i.e. the proportion of carbon emissions to GDP); the USA has offered to reduce emissions by 17% by 2020 compared with 2005 levels; and India has offered to reduce its carbon intensity by 24% over the same period.

However, as the Washington Post article below states, “During a weekend meeting, India, along with China, Brazil, South Africa and Sudan, decided it would not agree to legally binding emission cuts, international verification of reductions without foreign funding and technology, and imposition of trade barriers in the name of climate change.”

Meanwhile the news from Australia has come as a blow to those seeking to extend tradable permit schemes around the world. The Australian senate has rejected a bill to set up an Emissions Trading Scheme (ETS), designed to cut Australia’s carbon emissions by up to 25% below 2000 levels by 2020.

In the second of the linked articles below, Andy Atkins, from Friends of the Earth, argues that the European Emissions Trading Scheme (ETS) has failed to make any substantial cuts is emissions and is creating the opportunity for carbon traders to become very rich in increasingly complex financial products based on carbon. “This risks the development of sub-prime carbon and financial crisis – with a double whammy this time of environmental catastrophe to match.” He thus argues for alternative methods of reducing carbon, such as green taxes, tough regulation and government investment in green technology

But is the ETS a failure? In the third article, Alexandra Galin, from the Carbon Markets & Investors Association, argues that the second phase of ETS (2008–12) is much more successful than the first (2005–7) and that substantial carbon reductions have been achieved. Her argument is that a carbon trading scheme’s success in cutting carbon emissions does not depend on the trading system, but on the tightness of the cap. In other words, in a ‘cap-and-trade’ system, it is the cap that reduces emissions; the trading simply achieves the reductions in the most efficient way.

The following video and audio podcasts look at resistance by the US oil and coal industries to measures to curb the consumption of oil and coal. Despite the clearly estabilised link between burning fossil fuels and global warming, many in the two industries reject, or at least question, the evidence. After all, it is in their commerical interests to promote the consumption of fossil fuels!

Elsewhere in the USA, interesting scientific developments are taking place to combat global warming. One measure is the production of ‘green oil’ produced from algae. Growing the algae absorbs carbon from the atmosphere.

In few areas are economic arguments so intertwined with political ones. The podcasts look at some of the issues.

To what extent will the free market result in a shift to greener energy sources? Why will any shifts towards greener fuels still not result in the socially or environmentally optimum use of fossil and ‘green’ fuels without government intervention?

What policies could governments adopt to internatlise the externalities involved in burning fossil fuels?

How suitable are cap-and-trade policies (tradable permits) for tackling global warming? What conditions are necessary for such policies to be effective?

Why is tackling climate change politically difficult for (a) individual countries and (b) the world as a whole? How is game theory relevant to your analysis?

The traditional macroeconomic issues are well-known: unemployment, inflation, economic growth and the balance of payments. However, the environment, and specifically climate change, have become increasingly important objectives for the global economy. Over recent months, many countries have announced new policies and measures to tackle climate change.

The costs of not tackling climate change are well-documented, but what about the costs of actually tackling it? Why is a changing climate receiving such attention and what are the economics behind this problem? The articles below consider this important issue.

In a major break from the policy of the Bush administration, President Obama has announced that the US government will regulate greenhouse gas emissions. The US Environmental Protection Agency has found that CO2 emissions pose a ‘threat to public health and welfare’. This finding allows regulation to be imposed.

At the end of March the Democrats in the House of Representatives released a draft climate change Bill. Central to this would be a system of tradable permits. ‘Under this program, covered entities must have tradable federal allowances for each ton of pollution emitted into the atmosphere.’ (See 4th article below.)